It is a known fact that pension funds, in their quest to deliver returns that will maintain pre-retirement standard of living for retirees, are faced with trilemma in their asset allocation—namely profitability, liquidity and security.
Profitability is all about investing to achieve highest returns, liquidity rotates around the ability to answer to liabilities as at and when they fall due and security entails capital preservation.
In other words, it is a risk-reward balancing act. However, there is also a big concern that current asset allocation is too risk-averse and contributes to retirement poverty.
A 2012 survey by the Retirement Benefits Authority (RBA) revealed two unique characterisitcs of retirees (i) nearly all (94 percent) of the surveyed mentioned they have dependants (with the average number per retiree calculated as two dependants). (ii) All retirees surveyed earned monthly pensions that are below half of their pre-retiremement monthly salaries.
This is the definition of retirement poverty, which, to a large extent, has roots in asset allocation. For instance, in 2018, fixed income instruments (Treasury bonds and bills as well as corporate bonds) accounted for 43 percent of asset allocation (FY2009: 47.5 percent) while property accounted for another 20 percent (FY2009: six percent). While this is an allocation that speaks to the security as well as liquidity component of the trilemma, it cannot deliver sufficient post-retirement earnings that can maintain pre-retirement standard of living for retirees.
Asset managers, in my view, can still deliver strong alpha. By definition, alpha is the excess of risk-adjusted performance of an investment relative to a benchmark; for instance, if a fund delivered a return of 25 percent while the market benchmark delivered 15 percent, the excess of 10 percent is alpha.
And one way of achieving this is to partition investment portfolios using scheme members’ age profiles, with a view to determining how much risk they can onboard. In the same RBA survey, nearly 70 percent of retirees had contributed for a period of between 21 years and 36 years.
Compared against a retirement age of 60, this means that some members started retirement contribution as early as 24 years old. If you invest pension contributions for a 24-year-old member in a 30-year Treasury bond earning 14 percent per annum, he/she is definitely staring at retirement poverty.
Age partitioning can give trustees some flexibility in terms of risk, such that for members within risk-bearing age (typically below 40 years) their contributions can be invested in more risky, yet high returning, assets (such as asset-backed securities, derivatives and other alternative assets).
For members beyond risk-bearing age (typically above 50 years), their contributions can be invested in defensive assets such as Treasury bonds. But such a strategy also requires trustees to be switched on. Who are trustees anyway? Occupational pension schemes are normally set up under trust. Consequently, the scheme appoints occupational trustees whose core mandate is to look after (and invest) the scheme’s assets on behalf of members, their dependants and other beneficiaries.
At the core of it, trustees have visibility on investment decisions, in conjunction with fund managers (of course). However, in a lot of cases, the trustees’s knowledge of investments is usually not rich, yet they are expected to build and preserve pension wealth.
To help address that imbalance, the pension market needs to move away from occupational trustees and embrace corporate trustees. In most jurisdictions, corporate trustess are authorised by law to act in a fiduciary capacity for individuals and other corporations. They are switched on, investment-savvy and well ring-fenced from scheme sponsors.